Monthly Archives: September 2024

09.13.24
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Cash Flow Matching Done Right!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Most of us seek to climb the “ladder to success”. We also use ladders for important everyday activities. I’ll soon be back on a ladder myself, as year-end approaches and the Christmas lights are placed on my home. Despite the usefulness of ladders, there is one place where they aren’t necessarily beneficial. I’m specifically addressing the use of ladders for bond management as a replacement for a defeasement strategy.

There are still so many misconceptions regarding Cash Flow Matching (CFM). Importantly, CFM is NOT a “laddered bond portfolio”, which would be quite inefficient and costly. It IS a highly sophisticated cost optimization process that maximizes cost savings by emphasizing longer maturity bonds (within the program’s parameters capped at the maximum year to be defeased) and higher yielding corporate bonds, such as A and BBB+.

Furthermore, it is not just a viable strategy for private pension plans, as it has been deployed successfully in public and multiemployer plans for decades, as well as E&Fs. It is also NOT an all or nothing strategy. The exposure to CFM is a function of several factors, including the plan’s funded status, current allocation to core fixed income, and the Retired Lives Liability, etc. Many of our clients have chosen to defease their pension liabilities from 5-30 years or beyond. When asked, we recommend a minimum of 10 years, but again that will be a function of each plan’s unique funding situation.

CFM strategies are NOT “buy and hold” programs. CFM implementations must be dynamic and responsive to changes in the actuary’s forecasts of benefits, expenses, and contributions. There are also continuous changes in the fixed income environment (I.e. yields, spreads, credits) that might provide additional cost savings that need to be monitored and managed. Plan sponsors may seek to extend the initial length (years) of the program as it matures which will often necessitate a restructuring or rebalancing of the original portfolio to maximize potential funding coverage and cost reductions.

CFM programs CANNOT be managed against a generic index, as no pension plan’s liabilities will look like the BB Aggregate or any other generic index. Importantly, no pension plan’s liabilities will look like another pension plan given the unique characteristics of that plan’s workforce and plan provisions. The appropriate management of CFM requires the construction of a Custom Liability Index (CLI) that maps the plan’s liabilities in multiple dimensions and creates the path forward for the successful implementation of the asset/liability match.

Importantly, CFM programs are NOT going to negatively impact the plan’s ability to achieve its desired ROA. In fact, a successful CFM program, such as the one we produce, will actually enhance the probability of achieving the return target. How? Your plan likely has an allocation to core fixed income. Our implementation will likely outyield that portfolio over time creating alpha as well as SECURING the promised benefits. Given the higher corporate bond interest rates, an allocation to this asset class can generate a significant percentage of the ROA target with risks substantially below those of other asset classes.

When done right, a successful CFM implementation achieves the following:

Provides liquidity to meet benefits and expenses

Secures benefits for the time horizon the CFM portfolio is funding (1-10 years +)

Buys time for the alpha assets to grow unencumbered

Out yields active bond management… enhances ROA

Reduces Volatility of Funded Ratio/Status

Reduces Volatility of Contribution costs

Reduces Funding costs (roughly 2% per year in this rate environment)

Mitigates Interest Rate Risk for that portion of the portfolio using CFM as benefits are future values that are not interest rate sensitive.

No laddered bond portfolio can provide the benefits listed above. Whether you are responsible for a DB pension, an endowment or foundation, a HNW individual, or any other pool of assets, you likely have liquidity needs regularly. CFM done right will greatly enhance this process. Call on us. We’ll gladly provide an initial analysis on what can be achieved, and we will do it for FREE.

09.11.24
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Falling Rates – Not A Panacea For Pensions

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Milliman has reported that pension funding for Corporate plans declined in August. The Milliman 100 Pension Funding Index (PFI) recorded its most significant decline of 2024, as the funded ratio fell from 103.6% to 102.8% as of August 31, 2024. No, it wasn’t because markets behaved poorly, as the month’s investment gains of 1.81% lifted the combined plans’ market value by $17 billion, to $1.347 trillion at the end of the period. It was the result of falling US interest rates that impacted the liability discount rate on those future promises.

According to Milliman, the discount rate fell from 5.3% in July to 5.1% by the end of August. That 20 basis points move in rates increased the projected benefit obligations (PBO) for the index constituents by $27 billion. As a result, the $10 billion decline in funded status reduced the funded ratio by 0.8%. The index’s surplus is now at $36 billion.

Markets seem to be cheering the prospects of lower US interest rates that may be announced as early as September 18, 2024 following the next FOMC. Remember, falling rates may be good for consumers and businesses, but they aren’t necessarily good for defined benefit pension plans unless the fall in rates rallies markets to a greater extent than the drop in rates impacts the growth in pension liabilities.

“With markets falling from all-time highs and discount rates starting to show declines, pension funded status volatility is likely in the months ahead, underscoring the prudence of asset-liability matching strategies for plan sponsors”, said Zorast Wadia, author of the PFI. We couldn’t agree more with Zorast. As we’ve discussed many times, Pension America’s typical asset allocation places the funded status for DB pension on an uncomfortable rollercoaster. Prudent asset-liability strategies can significantly reduce the uncertainty tied to current asset allocation practices. Thanks, Milliman and Zorast, for continuing to remind the pension community of the impact that interest rates have on a plan’s funded status.

09.09.24
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ARPA Update as of September 6, 2024

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Football season has kicked off in earnest. If you are a NY Giants fan, as I’ve been for nearly 60-years, you are already looking forward to hockey! It wasn’t any better for fans of Notre Dame’s football team, which somehow lost to Northern Illinois.

Now on to the important “stuff”. With regard to the PBGC’s effort implementing the ARPA pension legislation, last week was quiet. There were no new applications filed or withdrawn. There were no new applications approved, but there was one fund that received payment on 9/3 for its approved application. Printing Local 72 Industry Pension Plan received $39.4 million in SFA including interest. In addition, there were no plans added to the waitlist at this time.

Carpenters Industrial Council of Eastern Pennsylvania Pension Fund repaid excess SFA as a result of incorrect census data. They forfeited $106,298.69 from the original grant payment of $14.1 million or 0.75% of the proceeds. At this time, 13 funds have repaid $139.3 million or 0.36% of the grants. Of course, most of the rebate was from Central States, as its repayment makes up 91% of the total funds recaptured.

Uncertainty surrounding the upcoming Presidential election and the potential impact on markets (bonds and stocks) from the candidates’ policies (taxes, capital gains, social safety net, geopolitics, etc.) should keep recipients of the SFA taking precautions before diving into an asset allocation decision at this time.

09.05.24
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Overbought?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

One of the greatest attributes of managing a cash flow matching (CFM) portfolio is the fact that we don’t have to predict the direction of US interest rates. Most of us don’t have a clue about the direction, let alone the magnitude of the potential move. With CFM, you build the portfolio, and the cost reduction (savings) is locked in on day one, as future values are not interest rate sensitive.

Clearly, we and the plan sponsor community would like to see US rates remain fairly elevated, as higher rates equate to lower cost and more savings when using a CFM strategy. They also mean that coverage of the annual return on asset (ROA) objective is more certain, as opposed to traditional asset allocation frameworks that come with incredible volatility (annual standard deviation) and greater uncertainty in this environment.

All this said, we, at Ryan ALM, are still students of the markets, especially related to interest rates and the factors that impact those rates, such as GDP growth, labor markets, wages, inflation, geopolitical risk, etc. Clearly, the US investing community is excited at the prospect of the Fed’s FOMC cutting rates on September 18th. There appears little question that the Fed will act at that meeting. What is unknown at this time, is the magnitude of the potential cut. Will it be 25 bps or 50 bps or something entirely different. Who knows? However, those engaged in fixed income management certainly seem to have decided that rates will fall precipitously, as the Fed finally realizes the “error” of its way and reduces rates in a very meaningful way.

However, as the chart above highlights, rates have moved rather dramatically already without any action by the Fed. Since May 31, 2024, US Treasury yields for both 2-year and 3-year maturities have fallen by >0.9%. By almost any measure, US rates were not high based on long-term averages. Sure, relative to the historically low rates during Covid, US interest rates appeared inflated, but as I’ve pointed out in previous posts, in the decade of the 1990s, the average 10-year Treasury note yield was 6.52% ranging from a peak of 8.06% at the end of 1990 to a low of 4.65% in 1998. I mention the 1990s because it also produced one of the greatest equity market environments. Given that the current yield for the US 10-year Treasury note is only 3.74%, I’d suggest that the present environment isn’t too constraining. In fact, I’d suggest that the environment is fairly loose.

Could it be that there’s been an overreaction to the potential Fed easing? Might Fed action that results in smaller and fewer cuts lead to yields backing up from these levels? Again, who knows? Since none of us do, why don’t you get out of the guessing game and retain a strategy that doesn’t need rates to move down in order to add value. Bring a significant degree of certainty to the management of pensions where great uncertainty is the present name of the game.

09.04.24
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Pension Myth #1: Earn the ROA…All is Well!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We are pleased to share with you a recent white paper produced by Ron Ryan, Ryan ALM’s CEO. In this excellent piece, Ron reminds us of the fallacy that achieving the ROA as an underfunded DB pension system will make everything good – it won’t! As he correctly points out, the funded ratio may remain the same, but the funded status will continue to deteriorate. If the pension plan is 60% funded, at a market value of $100, that system has a funded status deficit of $40. If that 60% funded plan achieves the 7% ROA, assets will grow by $4.20. However, liabilities at that same discount rate will grow at $7. After 5 years, the funded status will have deteriorated by >40% and the deficit will now be >$56.

DB Pension systems that are poorly funded need to work extra hard to keep pace with the growth in the promised benefits or contribute significantly more to close the funding gap. There aren’t many plan sponsors in a position to contribute whatever is necessary to keep the plan in good funded status. Ron also discusses the need for plan sponsors to produce an Asset Exhaustion Test (AET), which is a requirement under GASB 67/68. It is a test of solvency. Ryan ALM modifies the AET to accurately determine the required ROA to fully fund the liability cash flows. Has your actuary produced the AET for your plan? If not, would you like Ryan ALM to calculate the ROA needed to fully fund your plan?

Please don’t hesitate to reach out to us with any questions that you might have regarding this white paper. Also, don’t hesitate to go to RyanALM.com for all the research that we’ve produced throughout the years. We look forward to being a resource for you.

09.03.24
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ARPA Update as of August 30, 2024

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

We hope that you enjoyed a terrific Labor Day Weekend with family and friends. I can’t believe that we are 2/3rds of the way through 2024. Can you?

With regard to the PBGC’s effort implementing the ARPA legislation, there wasn’t a ton of apparent activity last week. We did have Teamsters Local 11 Pension Plan, a North Haledon, NJ (about 10 minutes from my home) non-priority plan file its revised application seeking $27.3 million in Special Financial Assistance (SFA) to help support the benefit promises to 2,012 plan participants.

There were no SFA awards last week. Furthermore, there were no applications denied or withdrawn. However, we continue to see some previous SFA recipients repay excess grant awards. In the last week, Laborers’ Pension Plan Local Union No. 186 and IBEW Local No. 237 Pension Plan repaid a total of $76,898.71 on grants of $79.8 million or 9.6 bps. Since the issue of overpayments due to incorrect census data was first recognized, nine pension plans have repaid a total of $138 million (mostly Central States) or 0.36% of the grants awarded.

There is still much to be done by the PBGC in completing the ARPA implementation. There are 113 potential applications that have yet to be approved, and in many cases, even reviewed (69). At this time, 44% of the expected applications have received SFA totaling $67.7 billion in SFA grants. That is an incredible total of benefits that have been secured. Let’s hope that the investment programs implemented are also securing those assets that have been received and benefits that have been promised.